Trade-offs are a fact of life in any acquisition of a troubled bank.

In the case of CoreStates Financial Corp.'s planned acquisition of Constellation Bancorp., gaining a stronghold in strategically important New Jersey is a prize for which CoreStates' bankers will pay dearly.

On the face of it, the deal is a stock swap valued at $320 million, or two times Constellation's book value. But analysts say that with costs associated with Constellation's loan problems, Philadelphia-based CoreStates will actually pay closer to three times book - a hefty price for a troubled bank.

Benefits Offset Cost

CoreStates bankers admit that the deal is costly, but say the benefits of the acquisition are worth the price.

"The trade-offs were at the heart of the decision," said Jorge Leon, vice president in charge of mergers and acquisitions, in a recent interview.

The acquisition, announced last week, will give CoreStates a leading share of consumer deposits in the attractive middle section of the Garden State.

When CoreStates merges Constellation's $2.3 billion in assets and 49 branches into its existing New Jersey subsidiary, it will become the state's fourth largest banking organization, with $6.5 billion in assets.

But these prizes aren't cheap. Nearly 10% of Constellation's assets are nonperforming. The acquisition will add $183 million in nonperforming assets to CoreStates' books on a proforma basis, bringing its ratio of nonperformers to total loans plus foreclosures from 1.90% to 2.73%.

Adding to Loan-Loss Reserves

To cover the problems, CoreStates will add $107 million to loan-loss reserves and charge off $41 million of nonperformers and $38 million of foreclosed real estate.

Dennis Shea, an analyst at Morgan Stanley & Co., estimates that these charges, combined with the other restructuring costs and potential capital contributions that may be necessary to shore up the New Jersey bank, bring CoreStates' total investment in Constellation up to approximately $446 million, or nearly three times the New Jersey bank's book value.

"We find this particular deal economically unexciting and symptomatic of the extraordinary premiums being offered in recent mergers," wrote Mr. Shea in a recent report on the transaction.

At least one other bidder agreed. First Fidelity Bancorp walked away from the deal because it wasn't willing to pay such a high price, said Anthony P. Terracciano, Fidelity's chairman and chief executive officer.

Mr. Jorge said CoreStates has taken steps to make sure all risks have been identified and has laid plans to deal quickly with Constellation's problems.

No Hidden Problem Credits

First, Mr. Jorge says that all problem credits have been unearthed. CoreStates has looked at Constellation's loan files twice - once during the bank's rights offering last year and again over the last few months. More than 50 officers reviewed 85% of the portfolio, leaving the bank confident that it has identified all the problem credits.

"We really think we have this one nailed down," said Mr. Jorge.

Second, the bank is already in discussions with several buyers about the sale of $50 million to $100 million of nonperforming assets. CoreStates retained Merrill Lynch & Co. to review the realty portfolio and put together packages for accelerated disposition. Mr. Jorge said the bank hopes to complete a sale as soon as the acquisition closes early next year.

CoreStates also plans to sell Constellation's sizable mortgage servicing operation, which is deemed nonstrategic.

The New Jersey bank services a $2 billion portfolio of residential mortgages.

CoreStates walked away from mortgage servicing in the 1980s, and has no intention of reentering the business, said Mr. Jorges. CoreStates will probably write down a small portion of the mortgage portfolio when the acquisition closes, then sell it as quickly as possible.

With such portfolios fetching around 1% of the total servicing contracts, CoreStates can expect to realize about $20 million from the sale.

CoreStates estimates that with the disposition of the mortgage business and the assets earmarked for quick sale, Constellation will contribute $29.4 million in earnings in the first year of the merger.

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